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Between a rock and a hard place


Blacktower Group

[email protected]

FOR PEOPLE with cash invested in banks or building societies, the last few weeks have probably been a worrying time.

Interest rate rises to curb inflation have been putting the squeeze on debtors in the US just as in the UK, but a domino effect from America may affect the options for investors around the world.

To begin with, the collapse of the sub-prime mortgage market in the US was prompted by recent rises in interest rates. These forced up payments for mortgage holders, which affected the most vulnerable sector of society the worst.

While higher interest rates always have a more striking effect on the lower-earning sectors of society, the problem was exacerbated in the US by the financial services industry offering this at-risk group tailored mortgage deals.

These sub-prime mortgages often let people borrow against their home’s future price growth rather than based upon the usual affordability principles.

However, higher interest rates coupled with falling property prices, which were creating negative equity in some areas, meant large numbers of people in the US had to default on their mortgage payments and risk losing their home. The collapse of this system could cost the US mortgage industry 50 billion dollars and the fallout, with resulting credit squeeze, has had an effect on this side of the Atlantic.

Bumpy ride

Northern Rock has almost 100 billion dollars worth of mortgages and is Britain’s fifth largest mortgage lender. It has achieved this despite having only 72 branches because it has borrowed money in the money markets for short periods, lent on long-term mortgages and then bundled up those mortgages and sold them to other financial institutions. Analysts reckon it may have up to 12 billion dollars in mortgages that need financing through the markets and until credit markets settle down it has no chance of raising that money. Banks and investors, who have had their fingers burned, have become wary of buying any mortgage debt, including Northern Rock’s.

Given the lack of credit available on world money markets, all banks are having greater than normal difficulties in getting funding. And some banks may have a bumpy ride, although the Treasury and the Bank of England have promised to help every bank hit by the credit crunch, as long as the underlying business is safe and sound. Therefore, unlike Northern Rock, not all banks and building societies can be assured of this government safety net. Where does this leave the normal investor if the worst happens?

The Financial Services Compensation Scheme (FSCS) is the UK’s statutory fund of last resort for customers of authorised financial services firms. This means that FSCS can pay compensation if a firm is unable, or likely to be unable, to pay claims against it.

The compensation limit has just been increased by the government to 35,000 pounds sterling from the previous figure of 31,700 pounds sterling. This applies to each person for the total of their deposits regardless of how many accounts they hold or whether they are single or joint account holders.  In the case of a joint account, FSCS will assume that the money in that account is split equally between account holders unless evidence is shown otherwise.

For people with more than 35,000 pounds sterling invested in UK banks and building societies, it may be sensible to spread the investment around more than one provider.

Nevertheless, a successful claim for compensation may take up to six months to be paid. Many offshore jurisdictions have no such compensation scheme or, if they do, will be limited to 20,000 euros. This brings perhaps a new perspective on the concept of “safety” in cash deposits and, whether a deposit account is the most suitable place for investment.

Of course, anyone who has money invested for their short-term requirements, typically where the capital may be required in the next three years, a deposit account is still probably the best place.  Nevertheless, many experts expect interest rates to level or even decrease, in an attempt to cool the credit squeeze problems. This may mean lower future returns on deposit investments.

Investment bonds

The probable end to interest rate rises is also supportive of our view that we anticipate the stock market returning to its upward path once the period of instability comes to an end. So perhaps this is a good time for everyone to review their investments.

Offshore investment bonds, sometimes known as wrappers, issued by insurance companies offer investors access to a wide range of investment funds and allow returns to roll up virtually tax-free until the bond is cashed. For Portuguese tax residents, there are further advantages in tax treatment on encashment.

Furthermore, unlike, offshore bank accounts, wrappers are not subject to the European Savings Tax directive. Therefore, there is no withholding tax applied or reporting to tax authorities. They are generally issued by subsidiaries of well-known UK and European insurance companies, operating in low tax jurisdictions such as Luxembourg, southern Ireland, Isle of Man and Channel Islands. These companies will generally not be affected by the credit squeeze in the same way as banks and building societies, thus offering greater peace of mind.

Offshore bonds, or wrappers, are becoming increasingly popular for expatriates as they can offer a wide range of tax efficient investment solutions including retirement and inheritance tax planning.

Please contact Steve Rodgers of Blacktower Group for further information. Call 289 355 685 or email [email protected]